Your latest New Year’s resolution for trading success

A new year and a new start. Curiously, many markets have made major turns on or around this time. Currencies are especially prone to it. And on the first trading day of 2014, Treasuries made their low for many years – and continued much higher into 2014, much to the amazement of most pundits who expected Treasury yields to fall.

So I would like to offer this New Year’s resolution if you are looking for one that does not involve diets or your weight: stay away from fixed ideas about what the market ‘should’ do.

Yes, make sensible high-probability forecasts, but unless the market follows your roadmap, be prepared to ditch your ideas and adopt one that conforms to what the market actually serves up.

Of course, those with rigidly fixed opinions will treat an adverse price as an ‘anomaly’ and will rationalise why it will soon resume the ‘correct’ path. Gold bugs are especially prone to this. Please don’t fall into this bad habit.

Loyalty is fine for marriage and football clubs, but not for trading.

The Sorcerer’s Apprentice 

Over the holidays, I have been catching up on some movies that have long been on my must-see list. One of my all-time favourites is Fantasia, a 1940 classic Disney animated feature which sets well-known classical music to very striking moving images.

The highlight for me is the Sorcerer’s Apprentice, where Mickey Mouse plays the apprentice who decides to try his hand at a magic trick far above his ability – after the sorcerer has retired for the night. Of course, it all goes disastrously wrong with Mickey unable to stop the brooms multiplying into a whole army that relentlessly carries pails of water which overflows the cellar.

Finally, the sorcerer is awakened and comes down to reverse the spell and dries the water up.

While watching it, I was struck by what a wonderful metaphor the fable is for the central bank ‘magic’ that has been sprinkled on the financial markets in the form of QE (quantitative easing) and ZIRP (zero interest-rate policy), otherwise known as ‘accommodation’.

With no idea of what they are doing – just as Mickey did – the central banks have created as if by magic gargantuan levels of liquidity (!), which has been flooding asset markets. We have yet to see the sorcerer appear – but he must surely be rousing himself as the New Year starts.

Will blind faith in the Fed finally crack this year?

As the year ended, the market’s belief in central bank magic continued unabated with many stock indexes at or near all-time highs. Japan is the latest in a long line of central banks to engage in mammoth QE money-printing with a record level of intervention (see Nikkei chart below). The European Central Bank is expected to be next.

For those of us who believe in honest markets and the genuine price-discovery mechanism of free markets, this is all very disturbing. We know it will end in tears for most. It is our task to ensure we escape that fate.

As a realist, I fully accept that the markets today are being heavily manipulated and are artificial. But the wonderful thing about my trading methods is that they continue to work in this ‘Alice in Wonderland’ environment.

On the charts, we still see tramlines, Fibonacci retraces and Elliott waves, regardless of the underlying motivations and manipulations of the major players.

That is because investors/traders/gamblers still act and react to the same impulses that have driven them since human life began. And the tides in these emotions are patterned according to the wave principle.

There is no doubt in my mind that eventually the asset market bubbles will burst spectacularly. It could kick off early in 2015.

One of the catalytic mechanisms will very likely be the collapse in corporate/sovereign bonds and even the ‘safe-haven’ US Treasuries – and a rapid rise in yields. Market sentiment has been extremely bullish for some time, and that is a situation that cannot persist. All markets move from top/extreme bullishness to bottom/extreme bearishness – and we are near the top now.

This places the Fed in a potentially vulnerable position. If Treasuries drop in value, their balance sheet will be damaged. The market will have their veil lifted and see the Fed not as the omnipotent Wizard of Oz of the markets, but as the arch-villain responsible for the financial disasters that have already occurred and those that are coming.

The Nikkei is flagging

One stock market index that is showing signs of fatigue is the Japanese Nikkei. The introduction of ‘Abenomics’ – a resumption of mammoth central bank money-printing – fired up equities last year, but in the last few days, the rally appears to be stalling. The charts look especially ominous when viewed through my charting method.

Here is the hourly chart showing the wonderful November wedge:

Nikkei 225 spread betting chart

The latest burst of QE was announced in October and the rally off those lows was in a clear five-wave pattern with wave 4 assuming a textbook rising wedge form.

The critical event was the break of the lower wedge line in early December and the subsequent rally up to the extension of that line – which now represented resistance.

And in the fading days of last year, the market made herculean efforts to break above that resistance in a series of kisses. But the effort was in vain and the market broke hard in a classic scalded-cat bounce down. This action demonstrates the awesome power of lines of support/resistance that can remain effective for a long time.

Remember, after a kiss, the most likely move is a rapid move away from that line. This is now setting up the possible Elliott wave labels off the 4 December top as waves 1, 2 and now 3. And we know how long and strong third waves can be!

The alternative view is that the move down is an A-B-C, but already a short trade taken at the latest kiss is in good profit.